Insight: Morgan Stanley wealth unit aims to close lending gap

In October, Rebecca Rothstein, a Beverly Hills-based private banker to rock stars, top executives and the otherwise rich, abruptly left Morgan Stanley for rival Merrill Lynch.

She had spent more than a decade at Smith Barney before Morgan Stanley took control of the retail broker from Citigroup Inc, but she was getting increasingly frustrated that the firm could not lend money to clients to refinance their yachts and vacation homes, people familiar with her thinking said.

So in the couple of minutes it takes to walk from one firm to another on Wilshire Boulevard - past palm trees, a Sotheby's realty office and the Mexican restaurant El Torito Grill - Morgan Stanley lost $2.5 billion in client assets to its rival.

In wealthy enclaves across the United States, Morgan Stanley has suffered a series of defections of top advisers such as Rothstein, in part because they think the firm is weak at providing loans to private banking clients compared with rivals owned by commercial banks.

Merrill, a unit of Bank of America Corp, has about 600 bankers working with brokers, for example, compared with 170 bankers at Morgan Stanley. In the third quarter, Merrill reported $1.5 billion in net interest income, compared with $410 million for Morgan Stanley's wealth unit.

"It's built right into the system at Merrill in terms of people and technology," said Mark Albers, a former manager at Merrill, who is now president of the wealth management recruiting firm Albers & Associates Consulting.

Albers said advisers at both firms have told him that lending is "significantly stronger and significantly easier" at Merrill than it is at Morgan Stanley.

Morgan Stanley spokesman James Wiggins said its wealth management unit offers competitive specialized loans through its tailored lending program. Although its loan book is not as big as rivals, the firm is working to build up that area and sees it as a significant growth opportunity, he said.

Morgan Stanley needs its Global Wealth Management unit to provide a steady income stream as traditional investment banking and trading businesses come under threat from more regulation, higher capital requirements and a moribund global economy.

The success of the wealth business depends on its ability to retain brokers, bolster profits from lending and other products, and curb costs. It could play a big role in determining Morgan Stanley's fate, as well as that of CEO James Gorman and the wealth management unit's head, Gregory Fleming.

"We're building wealth management to be one of the pillars of Morgan Stanley's future," Fleming said in an interview.

He now oversees some 17,000 brokers, on par with Merrill, making them the two largest U.S. brokerages.

Still, more than a dozen current and former Morgan Stanley brokers told Reuters they felt the firm's lending practices put it at a competitive disadvantage. Four brokers said they quit to join the likes of Merrill and Wells Fargo & Co in part because these firms made it easier to pitch loan products.

While Morgan Stanley has a robust securities lending business, brokers said the firm is not as strong when it comes to helping wealthy individuals finance specialized purchases such as yachts, luxury cars and organic farms. Brokers also say the firm does not consistently offer competitive lending rates.

"Lending was the main reason I left," said one adviser, who quit Morgan Stanley for Merrill within the past six months. "When people want to do business with you and you can't provide a solution, it impacts your ability to serve your clients, make money for the firm, and for my family."

The adviser said his clients wanted to do things such as secure lending and collateralized lending, which his team could not do easily at Morgan Stanley. In the past month at Merrill, he closed two lending deals and received an inquiry to borrow $80 million.

"Clients are looking for growth capital and now we can provide it," he added.

BALANCE SHEET

So far this year, Morgan Stanley's wealth unit has lost at least 233 advisers who, individually or in teams, managed at least $100 million in client money - more than twice the number who joined the firm, according to a Reuters tally of moves. They took with them about $37.8 billion in client assets, while those the bank poached from elsewhere brought in only $15.5 billion. (The figures are not complete, based on moves that have been announced and brokers managing at least $100 million.)

To be sure, brokers defect for a variety of reasons, including bigger compensation packages.

Bank of America, for example, offered Rothstein and her group nearly $30 million to move, according to a source familiar with the situation. Such payments are often staggered over a period of years, based on performance targets. A Bank of America spokeswoman declined to comment on the compensation package.

Morgan Stanley executives privately say Rothstein's exit was proof that Gorman and Fleming would not engage in bidding wars for brokers.

Nevertheless, the 77-year-old bank's fledgling status as a lender has become a source of broker unhappiness, according to some current and former employees. It has added to other frustrations: An ongoing $300 million a year cost-cutting effort has forced brokers to do more with less; a technology snafu over the summer; and legacy Smith Barney employees are having to adjust to a new culture at Morgan Stanley.

"Morgan Stanley puts itself at a disadvantage when its credit lending isn't firing on all eight cylinders," White said. "Lending is a major advantage for some advisers, particularly those who want to grow their business in as many ways as they can."

The departures have not dented revenue for Morgan Stanley's wealth business so far because asset outflow due to broker losses is just a fraction of the $1.77 trillion the business oversees. Revenue per advisor is increasing and executives are tightly controlling expenses.

The wealth management unit has become a big contributor to overall revenues at Morgan Stanley, accounting for 44 percent of third-quarter revenue excluding one-time charges, up from 21 percent in the same period five years ago.

On Tuesday, Fleming will provide investors with an update on the business at a Goldman Sachs Group Inc conference in New York, one of his first public presentations since joining Morgan Stanley in 2010. Morgan Stanley has earmarked $9.3 billion to complete the acquisition of Smith Barney by 2014.

Fleming and Gorman have pledged to deliver a pretax profit margin of roughly 15 percent from the wealth business by the middle of next year and upwards of 20 percent when global financial markets are performing strongly. Last quarter, pretax margin was 13 percent, excluding one-time costs, up from 12 percent the prior quarter.

"That's positive momentum for us in a relatively challenging marketplace," Fleming said.

RAMPING UP LENDING

In June 2011, Morgan Stanley hired Michael Brakey from Bank of America to become head of high net worth lending. Morgan Stanley does not offer auto lending and some other types of consumer loans, but it does offer mortgages, securities lending, personal loans and revolving lines of credit.

According to a marketing document, Morgan Stanley's wealth unit loans up to $100 million against liquid securities and up to $50 million against restricted stock. Those loans are appealing to top corporate executives who own large stock holdings in companies they founded or led.

In March, the firm also launched two co-branded credit cards with American Express Co for wealth management clients and has activated 10,000 cards since.

Morgan Stanley also plans to expand an existing lending relationship with its 22 percent shareholder Mitsubishi UFJ Financial Group Inc in investment banking to lend more aggressively to wealth clients. The Japanese bank wants to become a much bigger retail lender in the United States.

"There's a tremendous ability for us to grow here as we offer these products more broadly to our clients," Fleming said.

Still, for some brokers, Morgan Stanley is not fixing its lending issues fast enough.

Rothstein, 58, was one of the bank's most prominent and outspoken private bankers. When the firm had widespread problems with its new technology system last summer, Rothstein telephoned Gorman on behalf of other money managers to complain.

Gorman assured her the firm was fixing the problems, sources familiar with the situation said.

"When somebody as big and as smart as Rebecca - when that kind of person moves - it makes you question: 'Why am I staying?'" Albers said.

(Reporting by Lauren Tara LaCapra, Carrick Mollenkamp and Jessica Toonkel in New York; Additional reporting by Ashley Lau in New York and Nichola Groom in Los Angeles; Editing by Paritosh Bansal, Martin Howell and Andre Grenon)